Delta looks to its new fleet to drive revenue

ChristopherHinton

NEW YORK (MarketWatch) -- Delta Air Lines is moving cautiously to integrate its new fleet from the acquisition of Northwest, projecting that route and equipment optimization will help squeeze up to $2 billion in additional cash by 2012.

Atlanta-based Delta
DAL, -0.62%
closed its $3.2 billion merger with its Minneapolis rival in October, creating the country's first truly global airline in a generation with extensive domestic, trans-Atlantic and trans-Pacific connections.

Analysts have said the merger provides a unique, one-time opportunity for the airline to slash costs and strengthen its ticket pricing, helped by a diverse portfolio of aircraft that can be redeployed to better-performing routes, or parked to lower seat capacity.

That's going to be an important strategy to execute well in these troubled times. Though Delta said it expects to be "solidly profitable" next year, the industry as a whole is facing an 8% to 12% decline in revenue as travelers tighten their budgets in the current recessionary environment.

That's an unprecedented prediction. Declines in revenue have only happened two other times in the industry's near-80 year history, and each time the contraction was just 1% to 2%, according to Ed Bastian, Delta's chief financial officer.

"That's the worst industry revenue environment in history," Bastian said during an investor conference this week. Later he added the recession is expected to last into 2010.

A recent sharp decline in energy prices will provide a big upside and offset the loss in demand, Bastian said. Since hitting $147 a barrel in July, the price of oil has fallen well below $50 a barrel, benefiting Delta by about $5 billion.

To negate that blessing, passenger revenue would have to fall some 20%, Bastian said, which seems unlikely. After the terrorist attacks on Sept. 11, 2001, revenue fell off about 17%.

Park it, move it, put it to work

Being able to park older aircraft and lower seat capacity will play a key role in Delta's yield and revenue growth. Year to date, the airline's top-line revenue is up 11% in part because it was able to cut about 14% from its domestic capacity since 2006.

For 2009, Delta plans to remove between 8% to 10% of its domestic capacity, and 3% to 5% from international.

"Nobody has more tools in their war chest to increase their relative performance as a combined Delta and Northwest does today," said Glen Hauenstein, Delta's executive vice president of network planning and revenue management, speaking at the same conference.

"I would be incredibly disappointed if we did not outperform the industry," he said.

If fleet size indeed matters, the combined Delta-Northwest now has the world's largest with 685 aircraft. AMR Corp.
AMR, -1.63%
which owns American Airlines and previously had the No. 1 spot, has 635 planes.

It also helps that it is based in the world's largest airline market, the U.S., where foreign airlines are barred from owning more than 25% of a domestic airline and new low-cost rivals aren't likely with today's credit markets in shambles.

Further, being No. 1 both domestically and for most international destinations provides advantages with business travelers and global reservation systems.

Delta said it plans to redeploy the bottom 10% of its seat capacity, combining overlapping routes, mothballing older aircraft, and starting new routes to cities the airline doesn't serve.

Time slots at Detroit and Cincinnati hubs are already under scrutiny, Delta's Hauenstein said. The two airports already serve many of the same cities, so instead of having two flights departing for Buffalo, N.Y. from each hub at the same time, Delta can now break them up into separate times.

"Now they compliment instead of compete," Hauenstein said.

The same tactic will be applied to Atlanta, which has historically competed with Memphis, Tenn. At least one jet is scheduled to get pulled entirely and moved to a new route that will serve McAllen, Texas, which Delta doesn't currently serve.

"We are the world's largest airline and the largest domestic airline, and yet we didn't serve some relatively large domestic markets," Hauenstein said. "Those are the big upsides [to having a large fleet], and we're going to do that over, and over again."

The large fleet also has a lot of variety, with models from Boeing Co.
BA, +0.19%
Airbus, Bombardier Inc. (BBD.B), and McDonnell Douglas, which is now owned by Boeing.

Airbus is a unit of the European Aeronautic Defence & Space Co.
EADSY, -0.63%

"Though operating a wider number of aircraft will add cost, Delta benefits from being able to better match aircraft with demand," said Ray Neidl, an airline analyst with Calyon Securities.

On the other side, Delta said variety and size means it doesn't have any need to expand its fleet, and that will help to keep capital costs low; a top priority in a recession when a strong cash balance is a top priority.

How quickly Delta redeploys its fleet will depend on how well the airline integrates its fleet management and reservation software systems. Bastian, speaking at the same conference, said the carrier will be cautious.

"That's an area with some danger if you start to move your network capabilities ahead of both technology and operating systems," he said.

One thing that helped was an arbitration decision passed down this week on how pilots from Delta and Northwest should merge their seniority lists. Analysts have noted that getting pilots seniority straightened out early on will avoid a lot of damaging problems caused by labor unrest, such as delayed or canceled flights and poor customer service. See full story.

Holes remain in Delta's global coverage that redeployment might help, according to Rodger King, an analyst with bond research firm CreditSights. London's Heathrow, some trans-Pacific markets and America's west coast have yet to be fully tapped.

Delta has taken up an alliance with Alaska Air
ALK, -1.94%
to better serve the west coast, but King notes that the gaps are so numerous that only a merger could fill them.

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